Will China Come in for a Hard or Soft Landing?

Many issues have been causing concern for global investors over the past few months. Front and center is the never-ending European debt crisis. The situation in Greece is not improving, and lately investors have been dumping the bonds of even those countries previously considered to be sheltered from the storm, such as France. In this climate, China's slowing pace of growth has not been grabbing as many headlines. But it remains a major issue for managers trying to position their portfolios.

Even managers who don't focus exclusively on Asia say they must take into account their outlook for China's economy because of the impact that country's governmental policies and corporate actions have on stocks, bonds, and currencies around the world. No manager can think about the major resource companies in Brazil, Australia, or Canada, for example, without at least trying to gauge where Chinese demand for those commodities is heading.

In general, managers say that concerns about a "hard landing"--meaning that the Chinese economy will head south quickly and suffer a serious slowdown or even a recession--are overblown. Many, though, do expect China's economy to continue slowing, partly due to government actions, and they do worry about the country's financials sector in particular.

 "In China, we expect growth will slow, but by how much remains the question,"  Artio International Equity (BJBIX) managers Rudolph-Riad Younes and Richard Pell wrote to shareholders recently. "We do not see the hard landing expected by the markets ... in our view, China has ample latitude from both a monetary and fiscal perspective to deal with a slowing global economy."

Still a Big Deal
China is the largest emerging market when measured by market capitalization. At the end of November 2011, it made up 17.7% of the portfolio of  Vanguard Emerging Markets Stock Index (VEIEX), which tracks the MSCI Emerging Markets Index. China's share had been a bit larger one year earlier, at 18.6% of assets, but the weaker performance of its stock market compared with some others in the index brought down that figure.

That doesn't make China any less important, though.  "We believe that demand from China will continue to heavily influence emerging market performance, and that a hard landing is less likely now that China's growth rate has moderated to a more sustainable level," wrote Lazard Asset Management, which has extensive emerging-markets investments, in its 2011 Fourth Quarter Outlook.

Not Worry-Free
Some managers who doubt the likelihood of a sharp fall in China's economy nonetheless have concerns about its financials sector. For example, the managers of  Matthews Pacific Tiger (MAPTX) reported recently that they have an underweighting in Chinese financials partly because of uncertainty created by the growing amount of activity in the lightly regulated "gray loan" sector outside of the formal banking system.

Meanwhile, while they recognize the growth of what they call the "shadow banking" sector in China, the members of PIMCO's Asia-Pacific Portfolio Committee are less concerned that either that activity or rising property prices will have serious consequences for China. They cite the strong government responses to these issues, as well as other factors such as high levels of household saving.

Rajiv Jain of  Virtus Foreign Opportunities , who is among the minority of managers who take more seriously the possibility of a hard landing, also worries about China's financials sector. He doesn't think highly of the managements or accounting practices of Chinese banks, and he fears that government attempts to rein in rising property prices could have negative effects on the country's banks.

Austin Forey of  JPMorgan Emerging Markets Equity (JFAMX) agrees that China's banks are risky plays and that some observers doubt the accuracy of their financial reports. But he includes some in the portfolio because he feels they're attractive as franchises, have few problems with nonperforming loans, and are trading at cheap prices.

Something Wicked This Way Comes?
Domestic-fund manager Chris Davis, whose  Davis New York Venture (NYVTX) and  Selected American (SLADX) were hurt by scandal-plagued Sino-Forest and other China-related holdings in 2011, still thinks global leaders will emerge from China over the long term. He maintains positions in some Hong Kong-listed firms with long operating histories, such as China Merchants Holdings. Investors have to be ready for volatility, though. Davis has said, "anybody would be crazy to think that there would not be wicked corrections from time to time."